Transfer pricing, the Corona virus and positive cash management

The spread of the Coronavirus (COVID-19) and the related restrictions introduced by governments have a significant impact on the worldwide economy. In these uncertain times, cash management can be more important than ever before. In this blog we mention three ways in which transfer pricing could support you in this challenge. We would be pleased to discuss these and other options further with you.

1. Aligning the transfer pricing policy with economic developments

MNEs often work with target margins, for example for so-called routine operations performed by contract manufacturers, service providers or limited risk distributors. In regular market circumstances such target margins allow the principal/entrepreneur to make a reasonable profit. This would mean all entities are in a tax paying position.

Due to the consequences of the Coronavirus it is to be expected that in 2020 MNEs in several industries (such as tourism and hospitality) will end up in an overall loss-making position or achieve relatively low results.
If the regular target margins for routine operations would be maintained, the principal may incur large losses. This could result in a relatively high effective tax on group level with related tax cash effects.

Because the market risks of the extraordinary impact of COVID-19 can’t be escaped, it could be worthwhile to look if third parties in a similar position such as your company would renegotiate, certainly for the underlying year. Depending on your facts and circumstances, it may in that case be well defendable to adjust the routine remuneration and the targeted results for 2020 downward. This will probably have a material positive effect on the liquidity of the company.

In addition, many countries offer a so-called carry-back possibility. This carry-back possibility may allow you to offset losses made in the current year to profits made in the previous year. This could result in a positive cash tax position in this year.

To recap: aligning your transfer pricing policy with the current economic developments could create a positive cash tax effect in 2020.

2. Optimization of your intercompany finance

Various group entities may face liquidity difficulties in 2020. To make things worse, interest may become non-deductible if your borrowing costs are higher than 30% of the respective group entity’s EBITDA (earnings before interest, tax, depreciation and amortization).

However, as interest rates have plummeted in recent years there may well be some possibilities to lower your intercompany interest expenses.

In addition, tax authorities pay increased attention to the Transfer Pricing aspects of financial transactions as a result of the new OECD Guidance on financial transactions from February 2020. In one of our most recent blogs, we delved into the content and key takeaways of this new chapter.

To recap: we recommend to look at your intercompany financing structure for this fiscal year and the impact of an economic downturn on this. We would be pleased to provide a high-level analysis on what steps you could take to ensure liquidity and to limit the chance of ending up with non-deductible interest.

3. Alignment between revised business models and transfer pricing

Business models may have to be revised due to the consequences of COVID-19. This may have an impact on the results of the entities involved and result in new intercompany transactions or changes to current transactions. This can potentially have all kinds of cash tax effects.

Conclusion

To conclude we recommend the following three actions:

1.Aligning your transfer pricing policy with the economic development can save (tax) cash and increase liquidity.